About the Author

Garen Markarian is a professor of accounting at HEC, University of Lausanne. As an

international scholar specializing in corporate finance and governance, he has taught at WHU-
Otto Beisheim (Dusseldorf), the University of Iowa, IE Business School (Madrid), HEC
(Paris), Institut Mines-Télécom Business School (Paris), Bocconi, (Milan), Concordia
(Montreal), Rice (Houston), and Case Western Reserve (Cleveland). Previously holding the
position of First Regional Economic Officer for Western Asia at the United Nations, Dr.
Markarian has extensive experience in research on governance mechanisms, executive
compensation, the banking crisis, stock markets, and financial statements and valuation. His
publications have received awards both from the American Finance Association and the
American Accounting Association, and have been mentioned in the Financial Times,
Bloomberg, the Washington Post, and CFO magazine. Dr. Markarian has published in journals
such as The Review of Accounting Studies, Contemporary Accounting Research, and The
Journal of Banking and Finance, etc. Beforehand, he was a consultant for Standard & Poor’s
“Society of Industry Leaders,” as well as for start-ups and private equity. He was an executive
member of the scientific committee of the European Accounting Association from 2015–2020
and is currently an advisor at Lux Point Partners. Dr. Markarian has 20+ years of experience
in management education at the undergraduate, masters, executive, and Ph.D. levels. Dr.
Markarian has a Ph.D. from the Weatherhead School of Management at Case Western Reserve
University.

© Prof. Dr. Garen Markarian ^1

Introduction: What is Accounting?
Accounting is Sexy, Accounting is Fun

I love accounting!!!! Why??? Because: Accounting is Sexy, Accounting is Fun. What is

accounting? In a nutshell, accounting is the language of business—a tool that summarizes a
firm’s financial picture. Accounting addresses fundamental questions such as what assets we
possess, what liabilities we owe, how effectively we performed in the past year, and how our
performance has been over the past three years. Additionally, since current financial figures
are useful in predicting the future, accounting helps us understand a firm’s future prospects.

Accounting numbers are summarized into three financial statements: the Balance Sheet,
Income Statement, and Cash Flow Statement.

The balance sheet essentially summarizes a company’s net worth at any point in time. It shows
what the company owns, what is owes, and its net worth is. The income statement, or profit
and loss statement, describes the company’s financial performance for the current year,
indicating whether value was created or destroyed. The cash flow statement details a firm’s
cash transactions, showing how much cash was generated or disbursed from various activities:
operations, investments, and financing. The summary figures from Microsoft (MSFT) financial
statements for the year 2023 are as follows:

ACCOUNTING: SO EASY THAT EVEN CAVEPERSONS CAN DO IT!!!!

© Prof. Dr. Garen Markarian ^2

INCOME STATEMENTS

(In millions, except per share amounts)

Year Ended June 30, Revenue is what is 2023 2022 2021

generated from firm selling
Revenue: activities: Windows, Office,
Product etc. $ 64,699 $ 72,732 $ 71,074
Service and other 147,216 125,538 97,014

Total revenue 211,915 198,270 168,088

Cost of revenue:
Product 17,804 19,064 18,219
Service and other 48,059 43,586 34,013

Total cost of revenue 65,863 62,650 52,232

Gross margin 146,052 135,620 115,856

Research and development 27,195 24,512 20,716
Sales and marketing 22,759 21,825 20,117
General and administrative 7,575 5,900 5,107
Operating income is the income left
Operating income after covering all business costs, 88,523 83,383 69,916
Other income, net including wages, utilities, rent, 788 333 1,186
equipment use, R&D, and marketing.

Income before income taxes 89,311 83,716 69,916

Provision for income taxes 16,950 10,978 9,831
Net Income, “the bottom line”: is the number we
probably care about the most – whether we have
Net income $
made a profit or a loss! Obviously, the higher the
72,361 $ 72,738 $ 61,271
net income, the happier everyone is.
Earnings per share:
Basic $ 9.72 $ 9.70 $ 8.12
Diluted $ 9.68 $ 9.65 $ 8.05

Weighted average shares outstanding:

Basic 7,446 7,496 7,547
Diluted 7,472 7,540 7,608

© Prof. Dr. Garen Markarian ^3

BALANCE SHEETS
June 30, Assets are what a company owns, 2023 2022
including cash, inventory, receivables,
Assets property, equipment, patents, and
Current assets: investments.
Cash and cash equivalents $ 34,704 $ 13,931
Short-term investments 76,558 90,826

Total cash, cash equivalents, and short-term investments 111,262 104,757

Accounts receivable, net of allowance for doubtful accounts
of $650 and $633 48,688 44,261
Inventories 2,500 3,742
Other 21,807 16,924

Total current assets 184,257 169,684

Property and equipment, net of accumulated depreciation
of $68,251 and $59,660 95,641 74,398
Operating lease right-of-use assets 14,346 13,148
Equity investments 9,879 6,891
Goodwill 67,886 67,524
Intangible assets, net 9,366 11,298
Other long-term assets 30,601 21,897

Total assets $ 411,976 $ 364,840

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable $ 18,095 $ 19,000
Current portion of long-term debt 5,247 2,749
Accrued compensation 11,009 10,661
Liabilities are what a company
Short-term income taxes owes to others, such as unpaid
4,152 4,067
Short-term unearned revenue suppliers, loans from banks, and 50,901 45,538
Current finance lease liabilities taxes owed to the government. 1,197 1,060

Other 13,548 12,007

Total current liabilities 104,149 95,082

Long-term debt 41 990 47,032
Long-term income taxes 25,560 26,069
Long-term unearned revenue 2,912 2,870
Deferred income taxes 433 230
Operating lease liabilities 12,728 13,842
Other long-term liabilities 2,111 1,684

Total liabilities 205,753 198,298

Equity is simply assets minus
liabilities. What the company owns
Commitments and contingencies minus what it owes.
Stockholders’ equity:
Common stock and paid-in capital – shares authorized 24,000;
outstanding 7,432 and 7,464 78,520 71,223
Retained earnings 24,150 13,682
Accumulated other comprehensive loss (340) (2,187)

Total stockholders’ equity 102,330 82,718

Total liabilities and stockholders’ equity $ 286,556 $ 258,848

© Prof. Dr. Garen Markarian ^4

CASH FLOWS STATEMENTS The Cash flow statement shows
the firm’s cash activities.
(In millions)
Operations show cash flow from sales,
Year Ended June 30, including payments to and from customers, 2023 2022 2021
suppliers, employees, and the government.
Operations
Net income $ 72,361 $ 72,738 $ 61,271
Adjustments to reconcile net income to net
cash from operations:
Depreciation, amortization, and other 13,861 14,460 11,686
Stock-based compensation expense 9,611 7,502 6,118
Net recognized gains on investments and
derivatives 196 (409) (1,249)
Deferred income taxes (6,059) (5,702) (150)
Changes in operating assets and liabilities:
Accounts receivable (4,087) (6,834) (6,481)
Inventories 1,242 (1,123) (737)
Other current assets (1,991) (709) (932)
Other long-term assets (2,833) (2,805) (3,459)
Accounts payable (2,721) 2,943 2,798
Unearned revenue 5,535 5,109 4,633
Income taxes (358) 696 (2,309)
Other current liabilities 2,272 2,344 4,149
Other long-term liabilities 553 825 1,402
Net cash from operations 87,582 89,035 76,740
Financing Financing shows cash
Cash premium on debt exchange flow from paying
dividends, borrowing
0 0 (1,754)
Repayments of debt or repaying banks, and (2,750) (9,023) (3,750)
Common stock issued transactions with 1,866 1,841 1,693
shareholders.
Common stock repurchased (22,245) (32,696) (27,385)
Common stock cash dividends paid (19,800) (18,135) (16,541)
Other, net (1,006) (863) (769)

Net cash from (used in) financing (43,935) (58,876) (48,486)

Investing
Additions to property and equipment (28,107) (23,886) (20,622)
Acquisition of companies, net of cash
acquired, and purchases of intangible and
other assets (1,670) (22,038) (8,909)
Purchases of investments Investing shows cash flow (37,651) (26,456) (62,924)
Maturities of investments from buying or selling 33,510 16,451 51,792
assets like buildings, land,
Sales of investments machinery, patents, or 14,354 28,443 14,008
Other, net shares in other companies. (3,116) (2,825) (922)

Net cash used in investing (22,680) (30,311) (27,577)

Effect of foreign exchange rates on cash and
cash equivalents (194) (141) (29)

Net change in cash and cash equivalents 20,773 (293) 648

Cash and cash equivalents, beginning of
period 13,931 14,224 13,576

Cash and cash equivalents, end of period $ 34,704 $ 13,931 $ 14,224

© Prof. Dr. Garen Markarian ^5

Elements of Financial Statements

Elements of the Balance Sheet

Assets are defined as entities with current and future economic benefits. These include cash
(essentially everything the company owns), inventory such as unsold items of Office, Xbox,
laptops, and smartphones as well as land and property, like those owned by the corporation at
its headquarters in Redmond, WA, and globally. Assets also include amounts owed to
Microsoft by other corporations. For example, many companies that purchase large quantities
of goods from Microsoft with scheduled future payments are recorded as assets, even though
the goods have been sold but the cash has not yet been received. A promise of cash payment at
a future point in time is also considered an asset (these are called “Accounts Receivable”).

Under assets, we also classify subsidiaries of MSFT and all organizations that are directly or
indirectly owned and controlled by MSFT, with Hotmail, skype, LinkedIn, being such
examples. In essence, the balance sheet indicates that MSFT has assets totaling about $412
billion, which represents the sum of the value of everything owned by MSFT.

Liabilities are defined as entities with current and future economic outflows. For the physicists
among you, think of them as anti-assets. These include cash owed to other organizations and
individuals, as well as cash owed to banks and bondholders. Leased items are also classified
under liabilities.

Equity is best defined as assets minus liabilities. If a company has assets of $100 and liabilities
of $60 (a common scenario in modern corporations), then the net equity of the owners is $40.
Equity represents the claims of owners in the event the corporation is liquidated. When a
company goes into liquidation, all assets are sold for cash, creditors are paid, and what is
remaining (equity) is distributed to the owners. The higher this number, the better the financial
health of the firm.

Elements of the Income Statement

Revenues are all economic benefits to the firm resulting from corporate operational activities.
Essentially, it is the benefits derived from selling! For Microsoft, this would include the sale
of Office, Xbox, Operating Systems, etc. Revenues are usually in the form of cash and
receivables. Even if cash is not collected (i.e., there is only a promise to pay rather than payment
itself), accounting records it as revenue.
Expenses encapsules all items that represent the costs of operating the firm. They include the
cost of producing and selling goods, R&D, marketing, rent, employee and executive salaries,
taxes paid, and interest paid to banks.
Net Income represents the economic performance of the firm during a fixed period of time
(usually one year). It is the difference between revenues and expenses. The higher this number,
the better the firm’s success during a given period. Typically, promotions, bonuses, and
employee terminations are based on net income and other similar firm performance metrics.

© Prof. Dr. Garen Markarian ^6

Accounting in a Political World
Accounting rules were certainly not the lost third stone tablet brought down Mount Sinai, nor
were they part of the Ark or the revelation at Hira. These are human-made rules serving human
interests. The process of setting accounting rules is controversial and often the result of political
lobbying, frequently resembling a zero-sum game.

Currently, there are two main accounting rule-making bodies, one based in London and the
other in Washington, D.C. (USA). Being the world’s largest economic powerhouse, the USA
has its own set of rules that dictate how assets are valued and calculated, as well as the
components of income, revenues, and expenses. US GAAP (Generally Accepted Accounting
Principles) is used by corporations based in the USA, with minor variants used by its major
trading partners. On the other hand, the EU uses IFRS (International Financial Reporting
Standards), which are adopted by all EU countries under a 2005 directive.

For intermediate-level accounting students, the distinction between US-GAAP and IFRS is
minimal; we will learn “accounting fundamentals” that are common to both. However, where
there are striking differences, these will be pointed out. Despite the expectation that US-GAAP
would be abolished in favor of IFRS starting in 2011 (as per the SEC), it is now 2024 and
convergence has not occurred yet. Politicians have more pressing issues to address, as the world
has become increasingly complex. Since convergence is a political decision, the eventual is
uncertain and difficult to predict.

The setting of accounting rules is controversial because accounting impacts all aspects of
decision-making: lending by banks, profit calculation, hiring and firing of employees,
investment decisions, and promotions and expansions. As we shall see in the coming sections,
even small variations in accounting rules can lead to significant fluctuations in reported
numbers. For example, if a company reports profits of $300 million under one set of accounting
rules and a loss of $800 million under another, the specific rules applied have wide-ranging
implications for various stakeholders: shareholders, employees, competitors, the IRS, the
government, potential future employees and shareholders, the CEO, and others.

Never Ever Forget, Accounting is Sexy and Accounting is Fun!

© Prof. Dr. Garen Markarian ^7